PRINCIPLES OF BOOK-KEEPING

PRINCIPLES OF BOOK-KEEPING

A double-entry bookkeeping system is a set of rules for recording financial information in a financial accounting system in which every transaction or event changes at least two different nominal ledger accounts.

The name derives from the fact that financial information used to be recorded using pen and ink in paper books ? hence "bookkeeping" (whereas now it is recorded mainly in computer systems) and that these books were called journals and ledgers (hence nominal ledger, etc.) ? and that each transaction was entered twice (hence "double-entry"), with one side of the transaction being called a debit and the other a credit.

It was first codified in the 15th century by the Franciscan Friar, Luca Pacioli. In deciding which account has to be debited and which account has to be credited, the golden rules of accounting are used. This is also accomplished using the accounting equation: Equity = Assets - Liabilities. The accounting equation serves as an error detection tool. If at any point the sum of debits for all accounts does not equal the corresponding sum of credits for all accounts, an error has occurred. It follows that the sum of debits and the sum of the credits must be equal in value.

Double-entry bookkeeping is not a guarantee that no errors have been made ? for example, the wrong ledger account may have been debited or credited, or the entries completely reversed.

Accounting entries

In the double-entry accounting system, each accounting entry records related pairs of financial transactions for asset, liability, income, expense, or capital accounts. Recording of a debit amount to one or more accounts and an equal credit amount to one or more accounts results in total debits being equal to total credits for all accounts in the general ledger. If the accounting entries are recorded without error, the aggregate balance of all accounts having positive balances will be equal to the aggregate balance of all accounts having negative balances. Accounting entries that debit and credit related accounts typically include the same date and identifying code in both accounts, so that in case of error, each debit and credit can be traced back to a journal and transaction source document, thus preserving an audit trail. The rules for formulating accounting entries are known as "Golden Rules of Accounting". The accounting entries are recorded in the "Books of Accounts". Regardless of which accounts and how many are impacted by a given transaction, the fundamental accounting equation A = L + OE will hold, i.e. assets equals liabilities plus owner's equity.

Approaches

There are two different approaches to the double entry system of bookkeeping. They are Traditional Approach and Accounting Equation Approach. Irrespective of the approach used, the effect on the books of accounts remains the same, with two aspects (debit and credit) in each of the transactions.

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Traditional (British) approach

Following the traditional approach (also called British approach) accounts are classified as real, personal, and nominal accounts. Real accounts are accounts relating to assets and liabilities including the capital account of the owners. Personal accounts are accounts relating to persons or organisations with whom the business has transactions and will mainly consist of accounts of debtors and creditors. Nominal accounts are revenue, expenses, gains, and losses. Transactions are entered in the books of accounts by applying the following golden rules of accounting:

1. Personal account: Debit the receiver and credit the giver 2. Real account: Debit what comes in and credit what goes out 3. Nominal account: Debit all expenses & losses and credit all incomes & gains

Accounting equation approach

This approach is also called the American approach. Under this approach transactions are recorded based on the accounting equation, i.e., Assets = Liabilities + Capital. The accounting equation is a statement of equality between the debits and the credits. The rules of debit and credit depend on the nature of an account. For the purpose of the accounting equation approach, all the accounts are classified into the following five types: assets, liabilities, income/revenues, expenses, or capital gains/losses.

If there is an increase or decrease in one account, there will be equal decrease or increase in another account. There may be equal increases to both accounts, depending on what kind of accounts they are. There may also be equal decreases to both accounts. Accordingly, the following rules of debit and credit in respect to the various categories of accounts can be obtained. The rules may be summarised as below:

1. Assets Accounts: debit increases in assets and credit decreases in assets 2. Capital Account: credit increases in capital and debit decreases in capital 3. Liabilities Accounts: credit increases in liabilities and debit decreases in liabilities 4. Revenues or Incomes Accounts: credit increases in incomes and gains and debit decreases in

incomes and gains 5. Expenses or Losses Accounts: debit increases in expenses and losses and credit decreases in

expenses and losses

These five rules help learning about accounting entries and also are comparable with traditional (Britain) accounting rules.

Books of accounts

Each financial transaction is recorded in at least two different nominal ledger accounts within the financial accounting system, so that the total debits equals the total credits in the General Ledger, i.e. the accounts balance. This is a partial check that each and every transaction has been correctly recorded. The

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transaction is recorded as a "debit entry" (Dr) in one account, and a "credit entry" (Cr) in a second account. The debit entry will be recorded on the debit side (left-hand side) of a General ledger and the credit entry will be recorded on the credit side (right-hand side) of a General ledger account. If the total of the entries on the debit side of one account is greater than the total on the credit side of the same nominal account, that account is said to have a debit balance.

Double entry is used only in nominal ledgers. It is not used in daybooks (journals), which normally do not form part of the nominal ledger system. The information from the daybooks will be used in the nominal ledger and it is the nominal ledgers that will ensure the integrity of the resulting financial information created from the daybooks (provided that the information recorded in the daybooks is correct).

The reason for this is to limit the number of entries in the nominal ledger: entries in the daybooks can be totalled before they are entered in the nominal ledger. If there are only a relatively small number of transactions it may be simpler instead to treat the daybooks as an integral part of the nominal ledger and thus of the double-entry system.

However it is still necessary to check, within each day book that the postings from the daybook balance.

The double entry system uses nominal ledger accounts. From these nominal ledger accounts a trial balance can be created. The trial balance lists all the nominal ledger account balances. The list is split into two columns, with debit balances placed in the left hand column and credit balances placed in the right hand column. Another column will contain the name of the nominal ledger account describing what each value is for. The total of the debit column must equal the total of the credit column.

Debits and credits

Double-entry bookkeeping is governed by the accounting equation. If revenue equals expenses, the following (basic) equation must be true:

Assets = liabilities + equity

For the accounts to remain in balance, a change in one account must be matched with a change in another account. These changes are made by debits and credits to the accounts. Note that the usage of these terms in accounting is not identical to their everyday usage. Whether one uses a debit or credit to increase or decrease an account depends on the normal balance of the account. Assets, Expenses, and Drawings accounts (on the left side of the equation) have a normal balance of debit. Liability, Revenue, and Capital accounts (on the right side of the equation) have a normal balance of credit. On a general ledger, debits are recorded on the left side and credits on the right side for each account. Since the accounts must always balance, for each transaction there will be a debit made to one or several accounts and a credit made to one or several accounts. The sum of all debits made in each day's transactions must equal the sum of all credits in those transactions. After a series of transactions, therefore, the sum of all the accounts with a debit balance will equal the sum of all the accounts with a credit balance.

Debits and credits are numbers recorded as follows:

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? Debits are recorded on the left side of a T account in a ledger. Debits increase balances in asset accounts and expense accounts and decrease balances in liability accounts, revenue accounts, and capital accounts.

? Credits are recorded on the right side of a T account in a ledger. Credits increase balances in liability accounts, revenue accounts, and capital accounts, and decrease balances in asset accounts and expense accounts.

? Debit accounts are asset and expense accounts that usually have debit balances, i.e. the total debits usually exceeds the total credits in each debit account.

? Credit accounts are revenue (income, gains) accounts and liability accounts that usually have credit balances.

Debit

Credit

Asset

Increase Decrease

Liability

Decrease Increase

Income (revenue) Decrease Increase

Expense

Increase Decrease

Capital

Decrease Increase

Different type of subsidiary books

Subsidiary book may be defined as a book of prime entry in which transactions of a particular category are recorded. In other words, in order to save time and energy, the transactions which are of similar character are recorded in separate books; these are called subsidiary books or subdivision of journal. A number of subsidiary books are opened to record all business transactions. In practical system of book-keeping, subsidiary books are:

Cash Book:

Transactions held in cash or by cheque are recorded in this book. There are two sides in a cash book. In the left hand side all cash receipts are recorded and in the right hand side all cash payments are recorded. Cash Book is of five types: single column cash book, double column cash book, triple column cash book, bank cash book and petty cash book. In the single column cash book only receipt of cash and payment of cash are recorded.

In the double column cash book, receipt of cash, receipt of cash discount, payment of cash and cash discount allowed are recorded. In the triple column cash book along with the transactions which are recorded in double column cash book, cheque received and cheque paid are recorded. In the bank cash book the receipt of cheque, payment of cheque, cash discount allowed and cash discount

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received are recorded. In the petty cash book only small payments of cash are recorded by the petty cashier.

Purchase Book: All credit purchase of goods is written in this book. Cash purchase of goods and credit purchase of assets are not recorded in this book. Other names of purchase book are purchase day book, purchase journal, bought journal, inward invoice book etc. Sales Book: All sales of goods are written in this book. Cash sale of goods and credit sale of assets are not recorded in this book. Other names of Sales Book are Sales Day Book, Sales Journal, Sold book, Outward Invoice Book etc. Purchase Return Book: It may be necessary to return some goods that the firm has bought on credit for a variety of reasons. All returns of such goods are recorded primarily in Return Outward Book. This book is also known as Purchase Return Book. Sales Return Book:

Goods may be returned by the customers for a variety of reasons. All goods returned from customers are recorded in Sales Return Book. This book is also known as Return Inward Book.

Bills Receivable Book: When credit sales of goods are made the purchaser gives his guarantee to make payment in future in the form of bill. When the seller receives such bill, it is Bill Receivable for him as he will receive payment in future against such bill. In case a business house receives a number of bills, a Bills Receivable Book is maintained to record all such bills. Bills Payable Book:

When credit purchases are made by a firm it gives a guarantee to the seller to make payment in future in the form of a bill. This bill is said to be Bills Payable for the firm as he will pay for the bill in future. A Bills Payable Book is opened to record all such bills.

Journal Proper: It is a subsidiary book maintained to record the transaction which cannot be recorded in other special subsidiary books. Usually the transactions of infrequent character are recorded in the journal proper. The entries like adjustment entries, opening entries, closing entries, transfer entries, purchase and sale of assets on credit, interest on capital, interest of drawing etc. are recorded in journal proper.

Cash Book

Cash book is a book of original entry in which transactions relating only to cash receipts and payments are recorded in detail. When cash is received it is entered on the debit or left

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hand side. Similarly, when cash is paid out the same is recorded on the credit or right hand side of the cash book.

The cash book, though it serves the purpose of a cash book of original entry viz., cash journal really it represents the cash account of the ledger separately bound for the sake of convenience. It is more a ledger than a journal. It is journal as cash transactions are chronologically recorded in it. It is a ledger as it contains a classified record of all cash transactions. The balances of the cash book are recorded in the trial balance and the balance sheet.

Vouchers:

For Every entry made in the cash book there must be a proper voucher. Vouchers are documents containing evidence of payment and receipts. When money is received generally a printed receipt is issued to the payer but counterfoil or the carbon copy of it is preserved by the cashier. The copy receipts are called debit vouchers, and they support the entries appearing on the debit side of the cash book. Similarly when payment is made a receipt is obtained from the payee. These receipts are known as credit vouchers. All the debit and credit vouchers are consecutively numbered. For ready reference the number of the vouchers is noted against the respective entries. A column is provided on either side of the cash book for this purpose.

Balancing Cash Book:

The cash book is balanced at the end of a given period by inserting the excess of the debit on the credit side as "by balance carried down" to make both sides agree. The balance is then shown on the debit side by "To balance brought down" to start the next period. As one cannot pay more than what he actually receives, the cash book recording cash only can never show a credit balance.

Format:

The following is the simple format of a cash book:

Date Particulars

L.F. Amount Date Particulars

L.F. Amount

Single column cash book records only cash receipts and payments. It has only one money column on each of the debit and credit sides of the cash book. All the cash receipts are entered on the debit side and the cash payments on the credit side.

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While writing a single column cash book the following points should be kept in mind:

1. The pages of the cash book are vertically divided into two equal parts. The left hand

side is for recording receipts and the right hand side is for recording payments.

2. Being the cash book with the balance brought forward from the preceding period or

with what we start. It appears at the top of the left side as "To Balance" or "To Capital" in case of a new business.

3. Record the transactions in order of date. 4. If any amount of cash is received on an account, the name of that account is entered

in the particulars column by the word "To" on the left hand side of the cash book.

5. If any amount is paid on account, the name of the account is written in the

particulars column by the word "By" on the right hand side of the cash book.

6. It should be balanced at the end of a given period.

Posting:

The balance at the beginning of the period is not posted but other entries appearing on the debit side of the cash book are posted to the credit of the respective accounts in the ledger, and the entries appearing on the credit side of the cash book are posted to the debit of the proper accounts in the ledger.

Format of the Single Column Cash Book:

Following is the format of the single column cash book:

Date

Particulars

L.F. Amount Date

Particulars

L.F. Amount

Example:

Write the following transactions in the simple cash book and post into the ledger:

1991 Jan. 1 Cash in hand

" 6 Purchased goods for cash

15,000 2,000

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" 16 Received from Akbar " 18 Paid to Babar " 20 Cash sales " 25 Paid for stationary " 30 Paid for salaries " 31 Purchased office furniture

3,000 1,000 4,000

60 1,000 2,000

Solution:

Cash Book

Date

Particulars

1991

Jan. 1 To Balance b/d 16 To Akbar 20 To sales a/c

L.F. Amount Date

Particulars

15,000 3,000 4,000

22,000

Jan. 6 By Purchases a/c 18 By Babar 25 By stationary 30 By Salaries a/c 31 By Furniture a/c By Balance c/d

To Balance b/d

15,940

L.F. Amount

2,000 1,000

60 1,000 2,000 15,940

22,000

Akbar

1991 Jan. 16 By Cash

Sales Account

1991 Jan. 2 By Cash

Rs 3,000

Rs 4,000

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